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Buy-to-let property investing has generated impressive returns over the last 20 years or so as the housing market has risen inexorably. However, it is becoming a victim of its own success as the shortage of affordable housing has become a major political concern.

To tackle this problem and release more housing for owner occupiers, the government is taxing investment property owners more heavily, as well as introducing measures to assist purchasers with limited funds. At the same time, new tax concessions on investing in stocks and shares aim to steer private investment away from housing and into other industries. It is hoped that these measures will slow the rise in house prices and gradually make housing more affordable.

The changes to the taxation of these asset classes are some of the most significant for many years. Only time will tell whether they will have the impact the government desires. Nevertheless, investors should be aware of the details so that they can make informed choices.

For clients who are exposed to buy-to-let, or may be considering such an investment, we have produced a short guide to the changing landscape for buy-to-let and comparable investments. In it we outline the key tax changes, discuss the implications for people considering investing in a buy-to-let and compare buy-to-let to a discretionary fund management (DFM) portfolio. Given legal and tax differences, we have written separate versions for England/Wales and Scotland.

Higher costs for buy-to-let investors*

Key tax changes to note for buy-to-let investors:

stamp duty: buy-to-let investors face a 3% stamp duty surcharge when purchasing a property (for over £40,000) to rent out

mortgage interest relief: planned restrictions on tax relief on mortgage interest may eat into the income some landlords are able to generate from their buy-to-lets

“ Tax changes have put a considerable burden on buy-to-let investors. Additional costs are likely to eat into the return potential of rental properties.”

Investing in stocks and shares and some other non-property assets is now more attractive from a tax perspective, thanks to lower capital gains tax rates and new tax-free allowances on savings interest and dividends. For example, this year the annual ISA subscription limit has risen to £20,000, enabling investors to build a pool of tax-free assets more quickly. Since buy-to-let properties cannot be held in an ISA, landlords won’t benefit.

In short, tax changes mean that many landlords start at a disadvantage relative to those putting money into other investments. Investors with property portfolios may be able to preserve some of the tax benefits by transferring their assets into a company, but it is important to take advice on this.

Locked in

As an asset class, property is considerably more illiquid than listed equities and bonds. In a market downturn, it can take a long time to sell a house — tradable funds do not exist for the residential property market for this reason.

While you can sell a proportion of your DFM holdings if required, it is rarely possible to sell part of a flat. With buy-to-let, it is usually all or nothing when it comes to accessing your money, which has implications for using capital gains tax allowances efficiently.

It is also wise for landlords to keep some cash aside to cover unexpected repair bills and rental voids (i.e. periods when you don’t have a tenant). This ties up money that could otherwise be put to work.

In summary

Tax changes have put a considerable burden on buy-to-let investors. Additional costs are likely to eat into the return potential of rental properties, from both a capital gains and income perspective.

For many people, property has been a very successful investment over the years. Whether the trajectory of house prices can be sustained, time will tell. What we can say with certainty is that there are now more obstacles in the path of buy-to-let investors. Just to match the return on a medium-risk investment portfolio, property will need to significantly outpace stocks and bonds over the longer term.

*The tax rates referred to in this article depend on the circumstances of each client and may be subject to change in the future.

Key points

The government’s attempts to make housing more affordable are impacting many buy-to-let investors: